Has Norfolk Southern Become the Perfect Stock?

Finding companies that have all the right stuff can produce winners.

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Norfolk Southern(NYSE: NSC) fits the bill.

The quest for perfectionStocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.

Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.

Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.

Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.

Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.

Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Norfolk Southern.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

3.9%

Fail

1-Year Revenue Growth > 12%

14.6%

Pass

Margins

Gross Margin > 35%

37.3%

Pass

Net Margin > 15%

17.6%

Pass

Balance Sheet

Debt to Equity < 50%

83.0%

Fail

Current Ratio > 1.3

1.21

Fail

Opportunities

Return on Equity > 15%

19.6%

Pass

Valuation

Normalized P/E < 20

12.42

Pass

Dividends

Current Yield > 2%

2.8%

Pass

5-Year Dividend Growth > 10%

18.5%

Pass

Total Score

7 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Norfolk Southern last year, the company has picked up a point. Improvement in returns on equity is responsible for the boost, but the shares haven't kept up with the broader market as the industry faces some new challenges.

Like most railroads, Norfolk Southern has benefited from high oil prices, which makes rail transportation look more attractive compared to alternatives. Both Norfolk Southern and Union Pacific(NYSE: UNP) posted EPS increases of nearly 40% in their most recent quarters, with big share repurchases helping to add to the growth. Because Norfolk Southern is FedEx's (NYSE: FDX)primary eastern intermodal network provider, it especially benefits from conditions that favor rail over trucking.

One problem that many railroad companies have seen is the impact of low natural gas prices on coal shipments. Yet even as Appalachian coal leader Alpha Natural Resources(NYSE: ANR) has cut production of thermal coal for electricity generation, strength in domestic consumption of metallurgical coal has made up for falling exports and utility use.

Another way that Norfolk Southern is using low natural gas prices to its advantage is in delivering hydrofracking sand and drilling equipment to promising shale-gas areas. CSX(NYSE: CSX) saw sand shipments rise 40% in 2011 to 12,000 carloads, while Norfolk Southern boosted its total carloads to the Marcellus shale gas region by 67% last year.

For Norfolk Southern to keep moving forward, it needs to work on cutting its debt down to size. If growth continues at its current pace, though, Norfolk Southern could easily find itself even closer to perfection in the years to come.

Keep searchingNo stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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